Fitch to scrutinise booming $26bn derivatives market

Fitch has become the first ratings agency to launch a service covering credit derivatives, the burgeoning market for complex financial instruments, which is already causing concern among regulators.

Derivative Fitch will offer two ratings: a standard one for credit risk; and a specific market risk, taking into account things like stability, volatility, transparency and complexity.

Unlike straightforward corporate bonds and traditional loans, where the key risk is that the company will fail to pay its debts, credit derivatives involve the bundling of swaps, hedges and other financial instruments into bespoke packages for investors, often hedge funds.

Their risk depends not just on the credit worthiness of the issuing organisation, but on how they will behave in different markets and how they will interact with similar instruments.

The credit derivatives market has doubled in each of the last two years and, by the end of June, stood at $26 trillion (£14bn) and is forecast to grow to $33 trillion over the next two years.

Kim Slawek, head of Derivative Fitch, said the growth had so far matched the explosion in hedge funds, but she added that traditional investors, such as pension funds and insurance companies, 'are competing for returns with hedge funds and are investing in these instruments'.